Problem:
Read the Focus On International Issues in Fundamental Financial & Managerial Accounting Concepts. What other businesses may use this technique or a similar technique to speed up cash flow? What are some of the risks involved? What are the benefits?
FOCUS ON INTERNATIONAL ISSUES CASH FLOW PLANNING IN BORDEAUX
The year 2000 was considered the greatest year for wine in the Bordeaux region of France since at least 1982, and the winemakers could look forward to selling their wines for record prices, but there was one catch: these wines would not be released to consumers until late in 2003. The winemakers had incurred most of their costs in 2000 when the vines were being tended and the grapes were being processed into wine. In many industries this would mean the companies would have to finance their inventories for almost four years--not an insignificant cost. A company must finance its inventory by either borrowing the money, which results in out-of-pocket interest expense, or using its own funds.
The second option generates an opportunity cost resulting from the interest revenue that could have been earned if these funds were not being used to finance the inventory.
To address this potential cash flow problem, many of the winemakers in Bordeaux offer some of their wines for sale as futures. That means the wines are purchased and paid for while they are still aging in barrels in France. Selling wine as futures reduces the time inventory must be financed from four years to only one to two years. Of course there are other types of costs in such deals. For one, the wines must be offered at lower prices than they are expected to sell for upon release. The winemakers have obviously decided this cost is less than the cost of financing inventory through borrowed money, or they would not do it.
Companies in other industries use similar techniques to speed up cash flow, such as factoring of accounts receivable. A major reason entities prepare cash budgets is to be sure they will have enough cash on hand to pay bills as they come due. If the budget indicates a temporary cash flow deficit, action must be taken to avoid the problem, and revised budgets must be prepared. Budgeting is not a static process.